Choosing a Mortgage
When you do feel ready to take on the responsibility of buying your own home, you need to choose your mortgage carefully and shop around for the best deal to suit your needs.
There are dozens of different banks, building societies and other finance companies willing to lend mortgages and hundreds of different types of home loans on offer. So, before you even start looking for a property, it’s a good idea to find out as much as you can about mortgages and to consult different lenders about the amount you could borrow and the deals they offer.
Most lenders will be prepared to lend you up to around three times your annual earnings, depending on your financial commitments. If you want to take out a joint mortgage with your partner or someone else, you can usually borrow three times the highest earner’s income plus once the other income, or up to two and a half times the joint income.
Your main mortgage options
An important decision is whether to choose a repayment mortgage or an interest-only mortgage linked to a suitable investment.
With a repayment mortgage, each monthly payment you make to the lender repays part of the actual amount you borrowed (the ‘capital’ debt) plus part of the interest charged on the loan. This means that, bit by bit, you pay off everything you owe so you have the security of knowing that, by the end of your mortgage term, you will have paid off the mortgage in full. Repayment mortgage are likely to suit you best if you want the simplest, least risky type of mortgage arrangement.
With an interest-only mortgage, all you pay the lender each month is the interest on the loan. You don’t pay off any of the capital debt as you go along, so the size of your mortgage stays the same right until the end of your mortgage term. This means that it is up to you to find a way of paying off the capital debt at the end of the term. There are a number of options for this, one is to make another payment each month into some kind of investment such as an Individual Savings Account (ISA) or endowment, which, at the end of your mortgage term can be used to pay off your mortgage. There is a risk, however, that your investment will not grow sufficiently to pay off all of your loan, so you have less certainty than with a repayment mortgage.
You also need to think about the interest rate options available on mortgages.
- Standard variable rate
Where the lender sets up the rate of interest you pay and changes the rate up and down as often as it thinks necessary to suit market conditions. The downside of this is that your monthly repayments vary and you cannot be certain of how much you’ll be paying in the future. - Discounted rate
Where you pay the lender’s variable rate minus an agreed discount for a fixed period such as one or two years. This can be useful if you are on a tight budget because your initial payments are lower, but your payments will still go up and down as often as the lender changes its rates. - Fixed rate
Where you pay a guaranteed rate of interest for a fixed period, so you have the budgeting security of knowing your payments won’t vary. If you think that interest rates will go up, a fixed rate will protect you from rises in your mortgage payments. But if rates come down and if variable mortgage rates fall below your fixed rate, you will still have to pay the fixed rate. - Capped rate
Where the interest rate is variable but guaranteed not to go above a certain level or 'cap' for a fixed period, but it can fall. A capped rate deal will suit you if you want to be sure your payments will not go above a certain level, but do not want to have a totally fixed rate in case interest rates fall. - Cashbacks
(This isn't an interest rate option, but often combined with special interest rate deals) where you get a sum of cash back – often hundreds of pounds – when you take out the mortgage. They can be useful if you need some money up front for, say, furniture. But you can often find a cheaper interest rate if you go for a deal without a cashback.
If you go for a fixed rate, capped rate or cashback mortgage, you may have to pay a fee called an 'early redemption fee' if you want to pay off the loan early, before the fixed period of the deal expires. So, before choosing one, you should check that you understand how the fee works and under what circumstances you would have to pay it.
Flexible mortgages are designed for people who want to be able to vary their mortgage payments to match changes in their cash flow. To varying degrees, they let you underpay, overpay, take payment holidays, pay off lump sums and borrow on overpayments. They can be useful for self-employed people with a fluctuating income, but they do require a relatively sophisticated level of financial understanding and self-discipline. So they are not usually recommended for young, first-time buyers on tight budgets who are best advised to keep things simple and opt for a repayment mortgage on a fixed or capped rate.
